The two approaches most often used by government to help the economy grow are the Keynesian approach of stimulus spending and low interest rates, and the more free-market approach of tax cuts and deregulation.
We’ve seen both approaches used in recent years. Not surprisingly, the free market approach is winning. It’s not even close.
With the Federal Reserve Board running the economy, America experienced one of the longest, but also one of the weakest, economic recoveries on record. Keynesian stimulus spending doubled the federal debt, but the economy remained weak, even though it has historically been at its strongest after a recession.
As we’ve frequently noted, growth averaged just over 2%, compared with average growth of 3.3% from the end of World War II through the Great Recession. Keynesian economists like former Treasury Secretary Larry Summers, suggested that the economy could not grow any faster because it was being held back by “secular stagnation.”
The term secular stagnation, which originated with fellow Keynesian economist Alvin Hansen in the 1930s, was used to define the new, slower growth that affected America and other countries allegedly because of an aging population, a slowing rate of innovation and other difficult-to-control factors.
Deregulation and Tax Reform
We believed, though, that a record number of new regulations and high taxes were slowing growth. Many of the new regulations have been overturned and deregulation is continuing. In addition, tax reform put more money into consumers’ pockets and lowered what was the world’s highest corporate tax rate from 35% to 21%.
The results show that lower taxes produce greater growth and practically pay for themselves. Tax reform was signed into law at the end of last year and the U.S. economy has averaged 3.1% growth for the last six months, including 4.1% growth in the most recent quarter.
The average quarterly growth rate since 2017 began is 2.9%, which is almost 40% higher than the average rate during the previous eight years; gross domestic product on a per capita basis has grown 63% faster, according to The Wall Street Journal.
The Congressional Budget Office, which initially said GDP growth for 2018 would be just 2%, now forecasts that it will be 3.3%.
Impact on Federal Debt
Opponents charged that tax reform would blow out the federal debt, which has grown to $21.3 trillion. However, tax revenues grow when the economy improves. And tax reform eliminated many tax deductions and loopholes.
The CBO now has added $1.3 trillion to its 10-year revenue projection, according to The Wall Street Journal, “with the CBO’s April economic adjustment alone showing an addition of $1.1 trillion — the single largest growth-driven revenue gain ever reported. State and local governments can anticipate a similar dividend, amounting to as much as $600 billion.”
Added revenue from economic growth will offset 88.2% of the estimated 10-year cost of the tax cut, according to The Journal. As the chart shows, the CBO also estimates that growth results from tax cuts will cover the majority of the costs.
In contrast, the nonpartisan CBO found that the tepid economic growth from 2014 through 2016 cost $3.2 trillion in projected 10-year revenues — almost five times the amount of revenue than was gained by the 2013 tax increase.
So which approach should we follow moving forward — free-market capitalism or Keynesianism? In case you’re still not convinced that tax reform is working, we’ll consider other evidence tomorrow.